A property slump will affect the whole of Hong Kong's economy

Tom Holland

BIO

As the writer of the South China Morning Post’s Monitor column, Tom Holland attempts each day to make sense of the latest developments in business, finance and economic affairs in Hong Kong and mainland China.

Last week Monitor argued that the gradual tapering of quantitative easing and the eventual increase in American interest rates that will follow are likely to trigger a slump in Hong Kong property prices of 30 per cent or more.

That might sound like a good thing. Lots of families would like to buy. But with the minimum down-payment on a typical Hong Kong flat now equal to four years of median household income, many have been priced out of the market. To them, forecasts of a property slump are welcome.

But property prices do not fluctuate in isolation. In a city where the property market contributes a fifth of our gross domestic product, a big fall in prices will inevitably affect activity in all other sectors of Hong Kong's domestic economy.

First of all, a property bear market will erode consumer demand. With residential mortgage debt currently standing at 46 per cent of Hong Kong's GDP, a decline in the value of flats would have a big effect on household balance sheets.

For the hundreds of thousands of families paying off a mortgage on their flat, a fall in property prices would undermine the value of their assets relative to their liabilities, making them less inclined to go out and spend. That's not all. Falling property prices - and even the fear of falling property prices - will also affect the stock market, as the share prices of developers take a beating.

We've seen this factor at work recently. Even though home prices are up by 3 per cent over the last six months, the Hang Seng properties index of leading developers and landlords has dropped 15 per cent as investors anticipate falling profits over the next couple of years (see charts).

That hurts, because a weaker stock market makes investors feel less wealthy, adding to their reluctance to spend on big-ticket discretionary purchases.

Together, the direct impact of falling home prices and the indirect effect of a weak stock market can make a significant difference to consumer behaviour.

According to Marcella Chow at Bank of America Merrill Lynch, a 15 per cent decline in Hong Kong property prices relative to the prices of other goods and services knocks between 1 and 1.5 percentage points off the growth of private consumption spending.

A weak property market also hits investment. Most obviously, falling sale prices mean thinner margins for developers, which make investment in new construction projects less attractive.

But there is a second order effect, too. A softer property market weakens companies' balance sheets and chips away at banks' asset quality.

That makes companies nervous of investing, and banks less willing to lend to fund investments, especially in a city where the owners of small companies commonly put their own flats up as collateral against business loans.

Putting these two effects together, Chow estimates that a 15 per cent decline in the property market cuts private investment by almost 4 percentage points.

A decline in the value of flats would have a big effect on household balance sheets

On top of that, falling property prices eat into the revenues of the Hong Kong government, which both directly and indirectly relies on the property market for as much as a third of its income.

That shouldn't trouble officials too much, considering they have enough accumulated reserves to cover years of budget deficits.

Even so, the overall effect of a slump in the property market on Hong Kong's economy would be severe.

Chow is forecasting a 5 per cent decline in property prices this year, followed by a 15 per cent fall next year; a fall she expects to knock a full percentage point off the city's GDP growth in 2014, reducing it from 3.8 per cent to just 2.8 per cent.

But what you are forgetting is the dampening effect these absurd property prices have on our economy: the businesses shutting down because their landlord has doubled the rent, the inability of our young and creative entrepreneurs to be able to afford premises; the fact that if you go to a restaurant or even buy anything, a very large percentage of what you pay is going to a landlord who is doing nothing useful, constructive, or innovative for society whatsoever. Our tendency to put property above everything else just dampens everything else. A property boom affects the whole of Hong Kong's economy too, and not necessarily for the better.

HK_eh! Jul 18th 20139:00am

It's articles like these that try to influence the "sheeple" to think we can't let property fall because it will hurt your living. Irresponsible.Do you think the property market/prices is healthy for the HK people and their earning power?There is no pain free adjustment, but like going on a diet/exercise program to lose weight, if it's the right thing then take the pain and effort to do it or risk a worse blow up situation later.

m2leung Jul 18th 20139:42am

1. HK's property price has been artificially inflated by the USD peg. We need the free market to control home prices. This means dropping the peg and the artifically low interest rates that comes with it. Hong Kong's market driven interest rate would be higher than what the rate is today. We are not USA - our economy is inflating too fast, and we have no real GDP growth2. HK is in serious need of deflation. Coupled with the USD peg, we also suffer from a devaluing purchasing power due to the RMB appreciation in the last decade. What is the point of having 5% GDP growth but a 5.5% inflation? 3. People who did not listen to the government and not buy homes (John Tsang started his warnings as early as 2010) should be ready to commit suicide by coal burning when their home equity goes into negative. I have no sympathy for these people who do not do proper financial planning and risk analysis when making their home purchase. Speculation should not be rewarded. Greed should be punished.

Also, negative equity doesn't matter as much when you are genuinely buying a home to live in. It is the speculators who scream the loudest.But then this society cares more about the speculators than the people living in bed spaces and subdivided apartments. Rent controls are not unreasonable. We had them for years, and the sky did not fall.

aplucky1 Jul 18th 20138:34am

another self serving article ok tom holland reveal your property holdings in hong kong, just like your other slanted journalist buddy van der chumpwill bet everything you are at least holding one or more properties in hong kongyou and van der chump spout from your ivory towers about "transparency" so be transparent , what are you holding now

babyhenry Jul 18th 201311:06am

If HKer's got the guts to stick Tung property crash, HK will have been a much better place. But is garbage like these that eventually put "popular" tsang on and drove property to new highs. If HKer's suffer they have no one to blame but themselves. They were given an opportunity to restructure this twisted economy of property dependent drug addiction, and they demanded it during the hand over, but once your wish is granted, they flipped and turn their backs on their own demands and hyprocritically demanded responsibilities from Tung. Tom is right take away the drug those fools & parasites (agents) will be out in force looking for blood.

johnyuan Jul 19th 20131:21pm

Let Hong Kong free from property price control. Let inflation delivers our prosperity because property owners will feel happy and spend. Some studies said so. Then everyone or the entire society will benefit presumably through trickling down theory. So easily done just be greedy and speculative on property by any fat cat. Voodoo economy to the core -- new version and I wonder if US or any other country or place also wants to give it a try. A property price correction shouldn’t be called so negatively as a property slump. It is colored by prejudice and vested interest. Hong Kong will become better environmentally at least when property addiction comes to an end.
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There are many other ways people can feel happy with or without spending. A urban park at the Kowloon West landfill, for an example.

Giwaffe Jul 18th 20136:27pm

Some great comments below! =)Of course a drop in property values will reduce private discretionary spending, but this is only based on the rationale that a) people “feel wealthier/poorer” from perceived unrealized gains/losses on the value of their property and; b) borrowing against home equity to increase spending. Borrowing to increase consumption only works on the micro scale, but is actually unsustainable on a macro scale. Spending and investment should come from savings, not debt, otherwise the GDP increase from such spending and investment is only temporary.I would also argue that any slowdown to GDP from a property readjustment would be temporary, and GDP would increase once consumer expectations had adjusted. Government revenues could be protected by diversification, such as through increasing property taxes. This would increase the carrying cost on property which in turn discourages speculation and distortion of the property market, a fundamental need such as food and education.CY Tung had long term strategy vision. The property market was actually corrected to its historically reasonable levels at its lowest point back in 2003-2004 after SARS. It is unfortunate HK as a whole did not recognize this and work together to maintain that level. Otherwise, we would not be facing the multitude of social, economic, and structural ills that we face today.

Blame this on "Bow Tie" and his collusion with "Superman" and other developers.

Giwaffe Jul 19th 201310:31am

Ever since the property boom from the 1990s, economic growth has been substantially funded by credit (debt), which is very difficult to discern from non-credit funded economic booms.The property market is a case in point. When prices are low, individuals can afford to purchase property with just their savings. As prices rise, individuals must begin to borrow as savings alone cannot fund the property purchase. As prices continue to rise, some individuals become unable to purchase property even with borrowing. Obviously, there will come a time when the aggregate borrowing capacity of the people of HK is reached and no one in HK will be able to afford to buy property. One could argue there are external capital flows, but this misses the point. More importantly, a high price property market will divert future earnings and savings away from investment and into debt servicing, which leads to future stagnation and decline. The perceived "gains" of today are really just smoke and mirrors down the road.A scenario like this cannot possibly end well. What HK needs is a readjustment in the level of the property market so that future earnings/savings can be diverted away from debt servicing and into investment.